I've been digging into the question of paying off debt vs. investing and I'm coming to a conclusion that I haven't seen talked about elsewhere, which has me thinking that I must be overlooking something or doing the math wrong. So now I'd really appreciate some input.

The conventional wisdom says that you should compare the interest rate on your debt to the expected return on your investments. Ignoring the fact that debt payments represent a guaranteed return and investments do not (which I realize is not actually something to ignore), it's as simple as putting your extra money towards whichever return is higher. At least from a mathematical perspective.

Because I'm a huge weirdo I started wondering whether this was actually true and decided to create a spreadsheet to test it out. And the results are confusing me. Here's the spreadsheet if you'd like to take a look: https://goo.gl/RcWM18.

The basic scenario I ran was that you have a 10 year loan with $X minimum payment, $Y extra money to either invest or pay off debt, and a 30 year investment horizon.

What I found is that if you snowball the minimum payment once the debt is paid off - that is, once the debt is paid off you contribute both the $X minimum payment and the $Y extra money towards investments - then the conventional wisdom holds true. If the interest rate is the same as the investment return, it doesn't matter how you allocate that extra payment. Your net worth after 30 years is the same no matter what. If the interest rate is higher, you're better off putting the extra money towards the debt until it's paid off. If the investment return is higher, you're better off investing all the extra money from the beginning.

But if you DON'T snowball the minimum payment - that is, once the debt is paid off the $X minimum payment goes wherever and you only invest the $Y extra money - then it doesn't matter what the investment return, interest rate, or loan balance are. No matter what, you are better off investing 100% of the extra money from the very beginning.

This really confused me at first, but I eventually figured out that the reason this appears to be true is that you end up contributing more overall money by going this route. If you pay the loan off over 10 years, you are making 10 years worth of minimum payments, all of which are earning a return equal to the interest rate on the debt. But if you accelerate that payoff to, say, 5 years, you are making far fewer minimum payments and you are not compensating for that by making bigger investments down the line since you aren't snowballing the minimum payment.

I've run this with crazy numbers like a $500,000 loan at 100% interest compared to investments that return -25% and my numbers say that you still come out ahead after 30 years by investing all the extra money from the start. And the reason is that your total contribution is much higher when you go that route.

For example, let's assume that you have a $15,000 loan with a 25% interest rate and a 10 year term. The minimum payment is $341.24 and you have $200 extra dollars each month.

If you put all of that extra money towards your debt until it's paid off - which is what the conventional wisdom recommends - and then, once the debt is gone, invest just the $200 per month, you end up making a combined $86,332 contribution towards your debt/investments over 30 years and end up with a net worth of $155,976.

If you instead put all of that extra money towards your investments from the start, and still don't snowball your minimum payment once the debt is gone, you end up making a combined $112,949 contribution towards your debt/investments over 30 years and end up with a net worth of $200,903. That's $26,617 more contributed and a net worth that's $44,927 higher.

If this is right, and I am by no means sure that it is, the conclusion would seem to be that the conventional wisdom holds true IF you have the discipline to put your minimum loan payment towards your investments as soon as that debt is paid off. But if you don't, and I would think that behaviorally that would be pretty difficult to commit to, you are better off investing all of the extra money from the start, no matter what your debt situation looks like.

I've done some searching and haven't found anyone else talking about this question like this, which is only adding to my feeling that I'm doing something horribly wrong here. Which is why I'm seeking out other opinions.

I didn't look at your spread sheet. But, per your example, it doesn't appear you're accounting for interest saved by paying down the debt aggressively nor the total interest paid by paying the loan on schedule. Especially at a 25% rate, those numbers could be significant in your scenario. I also didn't run the numbers. But, what do those come out to be in your example?

The conventional wisdom says that you should compare the interest rate on your debt to the expected return on your investments. Ignoring the fact that debt payments represent a guaranteed return and investments do not (which I realize is not actually something to ignore), it's as simple as putting your extra money towards whichever return is higher. At least from a mathematical perspective.

The conventional wisdom is true. You may be overthinking this. 3 keys points here.

First, treat the debt as a negative bond. Mathematically that is what it is.

I didn't look at your spread sheet. But, per your example, it doesn't appear you're accounting for interest saved by paying down the debt aggressively nor the total interest paid by paying the loan on schedule. Especially at a 25% rate, those numbers could be significant in your scenario. I also didn't run the numbers. But, what do those come out to be in your example?

The spreadsheet is accounting for the interest saved by putting extra money towards the debt and that is accounted for in my example. Though I am certainly open to any input on how I may be doing the numbers wrong if you are willing to look at the spreadsheet.

The conventional wisdom says that you should compare the interest rate on your debt to the expected return on your investments. Ignoring the fact that debt payments represent a guaranteed return and investments do not (which I realize is not actually something to ignore), it's as simple as putting your extra money towards whichever return is higher. At least from a mathematical perspective.

The conventional wisdom is true. You may be overthinking this. 3 keys points here.

First, treat the debt as a negative bond. Mathematically that is what it is.

Lastly, always focus on the risk adjusted return of your portfolio. Leverage - borrowing cheap money to invest in higher risk higher return assets - always gets you higher returns and higher risk. Your home mortgage is a form of leverage. Modest, yes - but still true in the mathematical sense.

I agree wholeheartedly with the last point. However, I ran this simulation with 100% interest rate debt and -25% return investments, and investing the money still came out ahead unless you snowballed the minimum payment. Maybe the math is wrong, and I would love to know if that's the case, but if not then I'm not sure how to factor this point into the equation.

On your second point, I agree with it in theory but real world behavior is not always so logical. If you can truly commit to snowballing the minimum payment X years down the line when the loan is paid off, then great! But if that's not guaranteed, and anecdotally I would imagine that for many people it's not, then it would seem like it may not actually be an apples to apples comparison.

I didn't look at your spread sheet. But, per your example, it doesn't appear you're accounting for interest saved by paying down the debt aggressively nor the total interest paid by paying the loan on schedule. Especially at a 25% rate, those numbers could be significant in your scenario. I also didn't run the numbers. But, what do those come out to be in your example?

The spreadsheet is accounting for the interest saved by putting extra money towards the debt and that is accounted for in my example. Though I am certainly open to any input on how I may be doing the numbers wrong if you are willing to look at the spreadsheet.

I don't see it anywhere. So, I ran the numbers. Paying on schedule in your example would be $25,948 in total interest paid. Paying an extra $200/month from the start would be $18,340 in total interest paid or about $7600 in interest saved. Not all that significant, but still needs to be accounted for.

I didn't look at your spread sheet. But, per your example, it doesn't appear you're accounting for interest saved by paying down the debt aggressively nor the total interest paid by paying the loan on schedule. Especially at a 25% rate, those numbers could be significant in your scenario. I also didn't run the numbers. But, what do those come out to be in your example?

The spreadsheet is accounting for the interest saved by putting extra money towards the debt and that is accounted for in my example. Though I am certainly open to any input on how I may be doing the numbers wrong if you are willing to look at the spreadsheet.

I don't see it anywhere. So, I ran the numbers. Paying on schedule in your example would be $25,948 in total interest paid. Paying an extra $200/month from the start would be $18,340 in total interest paid or about $7600 in interest saved. Not all that significant, but still needs to be accounted for.

Actually paying an extra $200/month from the start would result in $7,608.83 interest paid, for a total savings of $18,339.90. And yes, that is factored into the numbers I provided in my example. I didn't state it explicitly, but all of the other numbers rely on it.

Where is that accounted for in your example? That narrows the gap by $18k then, right?

I would really encourage you to look at the spreadsheet if you'd like to question the numbers. I am more than open to a critique of my calculations - really that's the entire reason I started this thread - but I would ask that you do so after understanding what I did.

The example I provided accounts for many factors, including interest saved by accelerating the debt payment, total amount of money contributed, investment return, etc. So that $18k is already accounted for, and no the gap is not narrowed further. Unless, of course, you dig into the spreadsheet and are able to find an error, in which case I'd love to know what it is

I think you are mixing different questions, modifying variables without realizing it, and that's causing confusion. If you don't start investing any of the additional money after the loan is paid off, then you can simply remove the loan from the equation for your investment return. At that point, you are asking "Will I make more money by investing $200/month for 30 years or (30 - loan payoff time) years?" The loan terms don't matter, since the only variable that affects the outcome is when you start investing the $200, so of course starting sooner leaves you better off. If you don't include saving any additional money after the loan is paid off, then any losses from the loan payments over the first 10 years will eventually be offset by compounding gains over the next 20 years.

However, if your goal is to see which scenario gives you the highest net worth long term, then you can't really compare the snowball vs non-snowball methods, because you are effectively changing the amount you are investing very early in the non-snowball method. In the non-snowball method, you start investing [$200 + loan minimum payment(Negative bond investment)]/month, but once the loan is paid off, you are only investing $200/month. In the snowball method, you are calculating your net worth assuming the same investment for the entire time period. By disregarding the amount of the loan payment after the loan payoff, you've stopped comparing apples to apples. That money has to be accounted for if you want it to compare the outcomes.

I think you are mixing different questions, modifying variables without realizing it, and that's causing confusion. If you don't start investing any of the additional money after the loan is paid off, then you can simply remove the loan from the equation for your investment return. At that point, you are asking "Will I make more money by investing $200/month for 30 years or (30 - loan payoff time) years?" The loan terms don't matter, since the only variable that affects the outcome is when you start investing the $200, so of course starting sooner leaves you better off. If you don't include saving any additional money after the loan is paid off, then any losses from the loan payments over the first 10 years will eventually be offset by compounding gains over the next 20 years.

However, if your goal is to see which scenario gives you the highest net worth long term, then you can't really compare the snowball vs non-snowball methods, because you are effectively changing the amount you are investing very early in the non-snowball method. In the non-snowball method, you start investing [$200 + loan minimum payment(Negative bond investment)]/month, but once the loan is paid off, you are only investing $200/month. In the snowball method, you are calculating your net worth assuming the same investment for the entire time period. By disregarding the amount of the loan payment after the loan payoff, you've stopped comparing apples to apples. That money has to be accounted for if you want it to compare the outcomes.

I agree with all of this. I guess what I'm getting at, assuming the math is correct, is that in all of the pay off debt vs. investing commentary I have seen, I have never once heard anyone say that you have to put that debt payment towards some kind of investment once the debt is paid off in order for prioritizing debt to make sense. It's quite possible that many people have said just that and I've simply missed it. If so, I would love to know where that's already being discussed.

But if that point isn't part of the conversation, my first concern is that I would imagine there are many people who do not snowball their loan payments into their investment accounts once their debt is paid off, but who think they're coming out ahead because all they know is that you're supposed to pay off high-interest debt before you invest. And my second concern is that even if they do know that, the behavioral aspect of actually snowballing that debt payment into investments may be more challenging for many people than we'd like to believe.

But if that point isn't part of the conversation, my first concern is that I would imagine there are many people who do not snowball their loan payments into their investment accounts once their debt is paid off, but who think they're coming out ahead because all they know is that you're supposed to pay off high-interest debt before you invest. And my second concern is that even if they do know that, the behavioral aspect of actually snowballing that debt payment into investments may be more challenging for many people than we'd like to believe.

Getting out of debt is coming out ahead. While people may not "snowball" the extra money into investments, it allows one to say save for a 20% house down payment, pay cash for a car, etc. While not exactly seeing returns on investments, it benefits in that one saves money on interest from not having to take out other loans.

I agree with all of this. I guess what I'm getting at, assuming the math is correct, is that in all of the pay off debt vs. investing commentary I have seen, I have never once heard anyone say that you have to put that debt payment towards some kind of investment once the debt is paid off in order for prioritizing debt to make sense. It's quite possible that many people have said just that and I've simply missed it. If so, I would love to know where that's already being discussed.

But if that point isn't part of the conversation, my first concern is that I would imagine there are many people who do not snowball their loan payments into their investment accounts once their debt is paid off, but who think they're coming out ahead because all they know is that you're supposed to pay off high-interest debt before you invest. And my second concern is that even if they do know that, the behavioral aspect of actually snowballing that debt payment into investments may be more challenging for many people than we'd like to believe.

I think the target audience matters here. Snowballing and other techniques are designed to help people get out from under large debt loads, so they focus on the fastest way to pay them off. Investing isn't generally considered an important point until the debt has been either significantly reduced or eliminated. Part of those conversations have always involved reducing expenses and avoiding adding more debt at the same time you are paying off existing debts, building up an emergency fund, etc. Only after someone has successfully gotten through those steps does investing come up for discussion, and it usually leads to an entirely new investment plan, not a continuation of the debt reduction plan.(And the general consensus here is that you shouldn't necessarily take investment advice from someone just because they helped you get out of debt)

The impact of taxes is important for the marginal analysis. Loan principal and usually loan interest are paid back with after tax money, which for some of us means that a large percentage has already been lopped off. But if you can instead invest that money pre-tax and allow it to grow tax free (HSA) or tax deferred (tIRA or 401k) for a long time, it can have a profound impact on your net worth. I would need to be facing a terrible debt situation with high rates to consider prioritizing debt paydown over maxing an HSA and 401k.

But if that point isn't part of the conversation, my first concern is that I would imagine there are many people who do not snowball their loan payments into their investment accounts once their debt is paid off, but who think they're coming out ahead because all they know is that you're supposed to pay off high-interest debt before you invest. And my second concern is that even if they do know that, the behavioral aspect of actually snowballing that debt payment into investments may be more challenging for many people than we'd like to believe.

Getting out of debt is coming out ahead. While people may not "snowball" the extra money into investments, it allows one to say save for a 20% house down payment, pay cash for a car, etc. While not exactly seeing returns on investments, it benefits in that one saves money on interest from not having to take out other loans.

That's a very fair point. So maybe the requirement isn't that you snowball the payment into investments, but that you snowball it into something that produces a positive return. Paying cash for a car or putting 20% down on a home aren't "investments" in the traditional sense, but those moves can help you avoid interest payments and other costs, so there can be a positive return. If, on the other hand, that debt payment is simply spent, then no you are not coming out ahead from a financial standpoint. Though there may very well be good non-financial reasons to spend that money on other things, and in the real world those would be important to consider as well even though they're not really the part of the original question.

I agree with all of this. I guess what I'm getting at, assuming the math is correct, is that in all of the pay off debt vs. investing commentary I have seen, I have never once heard anyone say that you have to put that debt payment towards some kind of investment once the debt is paid off in order for prioritizing debt to make sense. It's quite possible that many people have said just that and I've simply missed it. If so, I would love to know where that's already being discussed.

But if that point isn't part of the conversation, my first concern is that I would imagine there are many people who do not snowball their loan payments into their investment accounts once their debt is paid off, but who think they're coming out ahead because all they know is that you're supposed to pay off high-interest debt before you invest. And my second concern is that even if they do know that, the behavioral aspect of actually snowballing that debt payment into investments may be more challenging for many people than we'd like to believe.

I think the target audience matters here. Snowballing and other techniques are designed to help people get out from under large debt loads, so they focus on the fastest way to pay them off. Investing isn't generally considered an important point until the debt has been either significantly reduced or eliminated. Part of those conversations have always involved reducing expenses and avoiding adding more debt at the same time you are paying off existing debts, building up an emergency fund, etc. Only after someone has successfully gotten through those steps does investing come up for discussion, and it usually leads to an entirely new investment plan, not a continuation of the debt reduction plan.(And the general consensus here is that you shouldn't necessarily take investment advice from someone just because they helped you get out of debt)

Again, I agree with everything you're saying in terms of how this topic is typically discussed. My overall question here is whether that default discussion is really the right way to have it. Assuming this math is correct (which is appears to be so far), I would argue that the default discussion is largely good BUT that there needs to be more emphasis on needing to do something productive with those debt payments once the debt is gone, having a specific plan in place for what that will be, and having a system to hold yourself accountable. Without that, putting all your extra money towards even high-interest debt may not be helping as much as people think.

I agree with all of this. I guess what I'm getting at, assuming the math is correct, is that in all of the pay off debt vs. investing commentary I have seen, I have never once heard anyone say that you have to put that debt payment towards some kind of investment once the debt is paid off in order for prioritizing debt to make sense. It's quite possible that many people have said just that and I've simply missed it. If so, I would love to know where that's already being discussed.

It is very possible you missed that. Saving or investing the payment once it's gone is mentioned in just about every thread about investing vs. paying off debt. It shows you joined the forum in 2012... and you have "never once" seen that mentioned??

...there needs to be more emphasis on needing to do something productive with those debt payments once the debt is gone, having a specific plan in place for what that will be, and having a system to hold yourself accountable. Without that, putting all your extra money towards even high-interest debt may not be helping as much as people think.

You have a payment on a loan of $500 per month and the annual interest rate is 5%. You have a total of $1000 available each month.

If you take the extra $500 and invest it at 5% or you take the $500 and put it on the loan at the end of a certain time period your net worth will be exactly the same.

The problem is never this easy because the assumption of having the same rate of return between the two isn't likely unless you have a guaranteed rate of return on your investment side.

You also need to do the calculation on a tax adjusted basis as a dollar invested is likely worth less than a dollar of loan paid back due to taxes that will be owed on the investment if you were to sell. Same goes for any tax deductions that may be on the interest of the loan if applicable.

Implicit in your counter-arguments is that there is a division between Homo Economicus (Rational Man) and Homo Sapiens (Normal Man). This is true. While spreadsheets and math will work on one, heuristics and rules of thumb work on the other. It is hard for the 2 to intersect.

It also assumes that one's income, consumption, savings rate, risk tolerance, and goals remain constant over 10 years. Probably not. Snowballing is normally pitched to people with low income relative to one's debts. It is a easy rule of thumb for them to get out of the bind they are in. Once they get out of their bind what is next? Rule of thumb verse spreadsheet.

BTW, have you read much in Behavioral Economics? It might be a good place to start to answer some of your questions.

I think you are mixing different questions, modifying variables without realizing it, and that's causing confusion. If you don't start investing any of the additional money after the loan is paid off, then you can simply remove the loan from the equation for your investment return. At that point, you are asking "Will I make more money by investing $200/month for 30 years or (30 - loan payoff time) years?" The loan terms don't matter, since the only variable that affects the outcome is when you start investing the $200, so of course starting sooner leaves you better off. If you don't include saving any additional money after the loan is paid off, then any losses from the loan payments over the first 10 years will eventually be offset by compounding gains over the next 20 years.

However, if your goal is to see which scenario gives you the highest net worth long term, then you can't really compare the snowball vs non-snowball methods, because you are effectively changing the amount you are investing very early in the non-snowball method. In the non-snowball method, you start investing [$200 + loan minimum payment(Negative bond investment)]/month, but once the loan is paid off, you are only investing $200/month. In the snowball method, you are calculating your net worth assuming the same investment for the entire time period. By disregarding the amount of the loan payment after the loan payoff, you've stopped comparing apples to apples. That money has to be accounted for if you want it to compare the outcomes.

I agree with all of this. I guess what I'm getting at, assuming the math is correct, is that in all of the pay off debt vs. investing commentary I have seen, I have never once heard anyone say that you have to put that debt payment towards some kind of investment once the debt is paid off in order for prioritizing debt to make sense. It's quite possible that many people have said just that and I've simply missed it. If so, I would love to know where that's already being discussed.

But if that point isn't part of the conversation, my first concern is that I would imagine there are many people who do not snowball their loan payments into their investment accounts once their debt is paid off, but who think they're coming out ahead because all they know is that you're supposed to pay off high-interest debt before you invest. And my second concern is that even if they do know that, the behavioral aspect of actually snowballing that debt payment into investments may be more challenging for many people than we'd like to believe.

I think the issue here that is causing you grief is the time period. Let's say that this isn't a choice of investing or paying off debt but instead 2 debts, one with a higher interest rate. To compare those 2 debts, you must look whether you come out better based on the time period on the 1st debt disappears. Over that time period, putting a set amount of money ($200) makes you come out better if put it towards the higher debt. If you had 3 debts (1 having the highest interest rate and shortest length and 3 having the lowest and longest length), you'd put the extra towards the highest rate debt 1. You would then compare the rates of 2 and 3 and pay 2 before 3. You would ONLY compare the time period until debt 2 was paid off. At that point, if it was your choice to pay extra to 3 or have your money sit in a checking account making 0%, it would obviously make more sense rate wise to pay off 3.

You are right...If you are going to compare a long period of time like you are, you MUST assume the same amount of money is being invested (it must be constant). However, when people are talking about snowballing, they are talking about debt which means you are comparing 2 pay off options and snowballing one into the other - not then investing. Those who invest generally make comparisons just by comparing the interest rates or running a differential analysis scenario. In other words, your spreadsheet doesn't compare apples to apples...you have too many variables changing - both interest rates and contributions to payoff/invest.

Yes, I agree with your post, and this is why we haven't rushed to pay student loans at the cost of investing for retirement. Making the minimum $300 per month student loan payment means that they money is tied up and put to good use. Freeing up that $300 opens up the possibility of increased spending.

This is 100% true. It is actually the entire reason I started looking into this in more depth. It seemed to me that most of the commentary on this topic assumed that you were either talking about a single extra payment or that your time period was the length of the loan, when the reality is that for many people their investment timeline is longer than their debt repayment timeline. That difference is what got me looking into the question of what you did what those debt payments once the debt was gone and how that might affect the analysis.

I agree with all of this. I guess what I'm getting at, assuming the math is correct, is that in all of the pay off debt vs. investing commentary I have seen, I have never once heard anyone say that you have to put that debt payment towards some kind of investment once the debt is paid off in order for prioritizing debt to make sense. It's quite possible that many people have said just that and I've simply missed it. If so, I would love to know where that's already being discussed.

It is very possible you missed that. Saving or investing the payment once it's gone is mentioned in just about every thread about investing vs. paying off debt. It shows you joined the forum in 2012... and you have "never once" seen that mentioned??

+1. That is either stated or so obvious as to be implied.

Of course investing $200/month for 30 years will come out ahead of investing $200/month for fewer years.

It seems to me you are answering the question: Will investing identical amounts for longer periods of time lead to greater wealth, even after subtracting a relatively minor amount of additional interest payments?

Is that your question? That is not a very useful question. The point of paying the debt early is to free up cash flow for additional uses (e.g. investing), and to do so at a guaranteed rate of return.

Perhaps the apples-to-apples comparison would be investing the saved interest on top of the $200.

But I'd think you'd also want to include the extra time in the market from the principal payments that go away early, too. I don't know.

I'm not very sophisticated about this stuff, so perhaps I'm just missing something here.

I agree with all of this. I guess what I'm getting at, assuming the math is correct, is that in all of the pay off debt vs. investing commentary I have seen, I have never once heard anyone say that you have to put that debt payment towards some kind of investment once the debt is paid off in order for prioritizing debt to make sense. It's quite possible that many people have said just that and I've simply missed it. If so, I would love to know where that's already being discussed.

It is very possible you missed that. Saving or investing the payment once it's gone is mentioned in just about every thread about investing vs. paying off debt. It shows you joined the forum in 2012... and you have "never once" seen that mentioned??

+1. That is either stated or so obvious as to be implied.

Hey look, I would be happy to find out that this point is regularly being discussed, or that everyone else (including outside of this community) already knows it to be obvious, and that I flat out missed it. Because that would mean that more people are aware of this than I thought, which would be a good thing.

But I still haven't seen the evidence that that's true. If you can point to it, I would love to see it. And that's not meant to be snarky. I would genuinely like to find out that I am flat out wrong about this.

That's just my reading of all the mortgage v. invest discussions. Maybe it's just me. But nobody is saying to get the guaranteed return of mortgage interest rate by paying it down early and then take the interest savings/earnings and set them on fire.

As I said above, it looks like the only tried relevant math in your calculations showed whether you end up with more if you invest 200k/month for 30 years or 25 years. The debt and interest is irrelevant, which is why insane interest rates have no effect on the outcome.

For the pay-down-early scenario, you should put the interest savings in years 5-10 into the investment for an apples-to-apples comparison. I'm curious to see what comes out ahead, and I'd bet the interest rates and rates of return on investments would become relevant.

You could also look at putting the principal payments into the investments at the point they are freed up. Accessing those earlier is one purpose of paying the mortgage of early.